This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

30 November 2008

Saving the Big Three

One of my favorite pundits, Bob Herbert, published a poignant column Saturday. In it, he described the human devastation that the Big Three would cause by closing. It was a moving piece.

Herbert didn’t exaggerate the consequences of a Big-Three shutdown. But neither did he answer the $64 trillion dollar question. How would our society gain by saving firms that make overpriced, lousy cars?

In order to solve a problem, you must understand it. Why are the Big Three’s American cars unlike all other cars in the world? Why are they more expensive, bigger, heavier, less efficient, and mostly of lower quality than their European and Japanese counterparts?

Every member of Congress, pundit, and think tanker who looks at our auto industry should answer those questions first. Until we do, we will only throw good money after bad and save nothing.

Careful readers will note that I referred to the Big Three’s American cars. That’s not a redundancy.

In 2000, I rented an American-label car in Europe. I think it was a Ford Focus. It was small, well designed, and well built. The doors clicked, not clunked, when they closed. It ran well over 100 MPH on Europe’s highways, many of which have no speed limit. It turned like a tiger, tracked like a rail car, and jumped like a rabbit. Although I didn’t check it myself, I presume that the mileage was passable in Europe, that is, about twice ours [fifth from last paragraph].

In other words, this foreign Ford Focus was as good as a Japanese car. Why couldn’t—or didn’t—the Big Three offer cars like it in their home country? Until we answer that question, no rational rescue is possible.

And don’t tell me they did. In 1973 I bought my first new car, as a young man with a good job. I spent days shopping. I tried a thing called the Chevrolet Vega, and I still recall how awful it was. The engine sounded like a sewing machine, ran irregularly, and made lots of noise even at idle. The tire roar was deafening even on surface streets, let alone the freeway. The steering was loose and imprecise, and the cabin interior looked like something from a Soviet factory. The car was a piece of junk. So I left the showroom to look at Japanese cars and never came back.

In the years since I have rented many an American car. It’s always been the same story. Foreign cars—especially Japanese—were demonstrably better in every respect. Even the early Hyundais were better. I still remember a rented Hyundai Sonata that drove almost like that European Focus. Now I’ve given up. Whenever I rent now (inside the United States) I don’t accept an American car without an argument. They just don’t measure up.

What kind of management would pursue such an abysmal business strategy over 35 years? Don’t the Big Three’s managers understand that brand loyalty begins with renters and first-time buyers? Are they brain dead?

The answer is costs—“legacy” costs in particular. Our auto workers’ health-care and pension expenses give the Big Three a $1,500 cost disadvantage for every car they make in the United States.

A whole chain of bad business decisions unraveled from those legacy costs. Because of them, the Big Three abandoned the small-car market, which is also the entry market, and went for size.

A $1,500 cost disadvantage is not as decisive in a $40,000 car as in one priced under $15,000. So the Big Three went for higher price. Since the quality of their cars couldn’t justify a higher price, they justified it by making the cars bigger, heavier and more powerful.

Not only did the Big Three seek to dwarf their legacy costs. They sought to regain the protected monopoly they had enjoyed before the foreign “invasion.” They didn’t just make bigger, heavier and less efficient cars; they made the biggest, heaviest and least efficient. They sought to create a new monopoly market for themselves alone.

For a time they succeeded. The Big Three had the dinosaur market all to themselves. Foreign car makers thought they were crazy and didn’t even try to compete.

But slowly, over a decade or so, foreign makers were tempted to share some of the easy profit from dinosaurs. They were always careful to position themselves just on the smaller, more rational side of size, just in case. Toyota bet its pickup success on the Tacoma—a truck smaller, more nimble, and more efficient but less powerful than the F-150 or the GMC. The same thing occurred in SUVs. This strategy collapsed for everyone when oil prices skyrocketed.

From a “bottom line” perspective, the Big Three’s counterproductive decisions might have seemed like rational business responses to their predicament. But those decisions were enormously antisocial. They wasted steel, aluminum, rubber and energy to make huge cars. The cars themselves wasted gas horrendously. The decisions accustomed a generation of Americans to a lifestyle of excess and profligacy, which came back to bite them when gas prices exploded.

And that was not all. The Big Three’s advertising compounded the evil. It led Americans to associate size, weight, power and excess with success and happiness. Then the Big Three loosed a scourge of Sherman tanks on our roads. In accidental collisions, they devastated more sensible cars. Exploiting that fact, the Big Three sold their excess as prudence, arguing that Americans preferred the relative safety of their inefficient Sherman tanks. The reductio ad absurdum was the Humvee, a commercial version of a gas-guzzling army personnel carrier.

Thus did financial necessity and the genius of American public relations combine to make “virtues” of anti-social conduct. For two generations, this unholy duo subverted the natural frugality, conservation, and moderation of a once Puritan, Calvinist society.

How did the Europeans and Japanese avoid these traps? Simple. Their governments paid for health-care for their workers and gave all workers above-subsistence pensions as a right of citizenship and employment. So the foreign makers had no legacy costs and no legacy-cost disadvantage.

Who is ultimately responsible for this dismal picture? The answer might surprise you—or maybe not. The culprit is the party of business, the very political party that once claimed to stand for moderation, frugality, and prudence.

In its modern, simplistic guise, the GOP now promotes two absolute propositions: (1) private business is always better than government; and (2) social obligations are best privatized. It has propounded this dogma for about forty years.

Taken together and translated into policy, these dogmatic principles have two consequences. First, the Big Three’s financial necessities—and the anti-social conduct that flows from them—are “virtues” because business always knows best. At least they serve the greater good of “consumer choice.” (Somehow “conservative” analysts never seem to question whether consumer “choice” is really free or deliberately conditioned by billions in advertising.)

Second, according to Republican orthodoxy, no one can take the health-care and pension millstones from around the Big Three’s necks because social obligations belong to the private sector, not government. So unions and management fought a decades-long war over these obligations, which our foreign competitors treat as burdens of their entire societies.

In all this our brilliant Republicans ignored another of their own dearest principles, economics’ most basic law: there is no such thing as a free lunch. In a civilized society, someone has to pay for health care and retirement.

If workers pay (in dollars or reduced benefits), many will forego health care, burdening the rest of us with the social consequences of high-cost emergency-room visits and poor health that could have been ameliorated by routine care. Some poor folk will just suffer and die. As for private pensions, we all know now what market downturns can do.

If the car companies pay (as has been our practice), their payments appear in the prices of their cars. The legacy-cost millstone renders them uncompetitive.

Only if government—the whole society—pays can workers have real security and the Big Three shed their legacy costs. Only then can the Big Three compete on a level playing field with foreign manufacturers that enjoy robust national health-care and pension systems.

Our Pension Benefit Guaranty Corporation is a tacit admission of these facts. To some extent, it is complicit in chiseling workers by whittling down their benefits through the miracle of bankruptcy, after which the PBGC takes over pensions. As I’ve argued in a separate post, the consequences are loss of social cohesion and societal weakness.

But the PBGC also has another, more salubrious purpose. After bankruptcy has “downsized” pensions, the PBGC makes sure they are paid. Although not supported by general tax revenues, it is a program administered by the federal government and created by federal legislation. It serves the same purpose as government-sponsored pensions in our trading partners—getting “legacy” costs off the back of industry.

Unfortunately, the PBGC requires a prior bankruptcy proceeding to achieve that end; without it, contractual legacy-cost obligations remain in place. And there’s the rub. In virtually every competitor nation, the government provides health care and reasonable pensions. In Europe and Japan, the pensions are more generous than our Social Security, but similar in form. So European and Japanese car makers have no legacy costs and don’t have to go through bankruptcy to shed them.

In contrast, our Big Three have to go through bankruptcy to shed their legacy costs, in the process chiseling their workers and raising questions about their warranty service, parts supply, and long-term viability. Compared to Europe and Japan, we have a lose-lose system, a Catch 22 of our own making.

Why is our system so dysfunctional? Because the Republican “conservatives” who have controlled our business and government for the last two generations are conflicted and self-contradictory. They want an unfettered, competitive private sector, but they weigh it down with health-care and pension costs that every other industrial nation pays collectively.

Why are they so confused? Because they fear the word “socialism” as much as they fear terrorists. They treat social obligations as unmentionables.

This attitude toward collective social obligation is destroying our society and rendering our nation uncompetitive. It obliterated our consumer electronics industry and is decimating our auto industry. It has nearly erased our fine New England virtues of frugality, moderation, conservation, prudence, and mutual helpfulness. It has produced the most profligate and wasteful transportation system on Earth, and it is undermining our personal morality.

So before anyone asks for my tax dollars to save the Big Three, I’d like them to answer some questions. How can we get the same quality in cars that the Big Three sell here as in ones they sell abroad? Can we do that without changing management down to its roots and rebuilding our domestic factories? If not, how do we make change without making things worse? Would receivership work, and how long and how much would it take? Finally, can we lift the legacy costs off the Big Three’s backs without stiffing workers and without abandoning our national delusions about health care, pensions and “socialism”?

While a good business plan might answer some of these questions, no business plan short of bankruptcy can shed legacy costs. And no plan that fails to shed them will be more than a charade.

Sleight of hand cannot make legacy costs go away. That approach has led our industry to the brink of bankruptcy. Nor should we expect workers—especially those nearing retirement—to surrender their benefits out of misguided “patriotism.”

So our leaders had better not join the national delusion, or they will lose all credibility. Instead, they must answer these questions—all of them—before adopting any bailout plan.

Unless and until they do so, a bailout will be a universally unpopular act (except among auto industry insiders) notwithstanding natural sympathy for displaced workers. More important, we will face additional future bailouts as far ahead as we can see. Failing to deal fairly and decisively with legacy costs will just kick the can down the road.

We “won” the Cold War. We are still free and capitalist. We don’t have to fear the ghost of Karl Marx. He is long dead, and his ideas are as thoroughly discredited as anyone’s could be. What we do have to fear is our own ideological stupidity, which none of our international trading partners or competitors shares.

Until we shed that, there will be no comfort or profit for what remains of our heavy industry, the Big Three, or their workers. We will keep losing industries, jobs, and market share to more rational and humane competitors, i.e., to those who lack our internal conflict about sparing their industries the burdens of social costs. Maybe if Republicans think of foreign health-care and pension systems as a subtle and entirely legal form of trade protectionism, inviting retaliation, they will understand at last.

3 Comments:

When I examine the situation more carefully, I think you're wrong on legacy costs as the reason why the Big Three focused on oversized gas-guzzlers.

Legacy costs were paid to retired workers, and were thus independent of the number of cars currently being produced. They would thus not incentivize the manufacturers to sell a smaller number of expensive cars rather than a larger number of cheaper ones.

I'd suspect the real driver of Detroit's focus on size was financialization. The Big Three did not make a profit by selling cars, but rather by selling loans. This gave them an incentive for them to focus on big cars (which are expensive enough that very few people could buy one without taking out a loan) rather than small cars (which many people would pay for up-front, thus depriving the seller of the loan interest).

There’s a key difference between revenue and gross profit. Revenue doesn’t fund sunk costs like pensions, as most of it goes toward the cost of goods sold. Gross profit does.

The simple fact is that, with constant margins, you make more money selling expensive cars. A 25% gross profit margin yields $2,500 on a $10,000 car and $10,000 on a $40,000 car. (Carrying manufacturing costs were no problem for the automakers during the era at issue: the banks would give them all the money they wanted at reasonable rates.)

Also, your implicit assumption that a higher price would sell “a smaller number of expensive cars” may not be valid. The usual laws of supply and demand doesn’t work precisely for cars (at least in America) because: (1) cars are vital necessities here, except in a few big cities, (2) cars were and are financed in such a way as to “soften the blow” of cost by spreading it out over most of a decade, and (3) car makers sold big cars on power, style, prestige, and capability (e.g., for big families and small businesses desiring pickup trucks).

The fact is, the automakers largely guessed right, at least at first. It took about two decades for the Japanese onslaught to convince us Yanks that, for most of us, well-built small cars got us around better and more cheaply than badly built big ones.

But the automakers failed to read the clear writing on the wall, as their quality got worse and gasoline got more expensive. If they had changed strategy just five years earlier, they might not have needed a bailout at all. Even as it was, Ford didn't.

Note that I haven’t mentioned the lack of conservation and waste of resources arising out of continuing to market and sell (for financial reasons) big cars that most of us Yanks didn’t really need.

Links to this post:

About Me

This blog reflects a quarter century of study and forty years of careers in science/engineering (7 years), law practice (8 years) and law teaching (25 years). A short bio and legal publication list appear here. My pre-retirement 2010 CV appears here.
As I get older, I find myself thinking more like an engineer and less like a lawyer or law professor. Our “advocacy” professions—law, politics, public relations and advertising—train people to take a predetermined position and support it against all opposition. That’s not the best way to make things work—which is what engineers do.
What gets me up in the morning is figuring out how things work and how to make them work better, whether they be vehicles, energy systems, governments or nations.
This post explains my respect for math and why you’ll find lots of tables and a few graphs and equations on this blog. If you like that way of thinking, this blog is for you.